Good Deal: Kohlberg Kravis Roberts & Co.'s acquisition of Duracell (1988)
Good Deal, Bad Deal

Although the brand name was more valuable than analysts thought, KKR's secret weapon was management participation.

What Went Right:
KKR arguably overpaid for Duracell by a significant amount. Although the brand name was more valuable than analysts thought, KKR's secret weapon was management participation. With a properly motivated management, cash flow increased dramatically, and both management and KKR made huge amounts of money.

In may 1998, Kohlberg Kravis Roberts & Co. (KKR) engineered the buyout of Duracell from Kraft for $1.8 billion. This deal succeeded grandly for KKR and its investors, not because KKR did a superior job of buying and selling assets, but because it did a superior job of managing them. It got management working much more effectively than it worked for its previous corporate parent, and KKR, its fund investors, and Duracell management were handsomely rewarded.

The terms of the deal were not dictated solely by economic interest. Kraft was pursuing a two-year strategy of divesting itself of its non-food businesses. At $1.8 billion, KKR outbid its competitors by at least $500 billion and shocked analysts with the price, who thought Duracell was worth no more than $1.2 billion. Part of the disparity can be attributed to the market's recognition around this period of the premium value of recognizable brand names. (Warren Buffett, in his greatest financial maneuver, bought $1 billion in Coca-Cola stock at the same time KKR was buying Duracell.) KKR could also afford the full price because it had management's eager participation.

The deal called for $350 million in equity financing. In addition KKR convinced 35 Duracell managers to take 9.85 percent of Duracell's stock, either paying cash for it or taking it in the form of stock options as compensation. (By the time KKR sold the company eight years later, the value of this stock jumped 11-fold).

Management soon bailed KKR out of any charged that it overpaid. Freed from Kraft's giant corporate bureaucracy, which was experienced primarily in food companies, management was able to convince it new owners, despite the heavy debt levels, of the importance of improving research and development. Management's financial participation assured that the money was spent wisely.

All aspects of performance improved with management ownership. They boosted cash flow by more than 50 percent in the first year after buyout and by nearly 20 percent per year after that.

In May 1991, KKR took Duracell public, issuing 34.5 million shares at $15 per share. In October 1991, KKR sold enough stock to recoup its $350 million in equity. It made additional secondary offerings in Novermber 1992 and march 1995. Although it sold no stock initially, its participation in the secondary offerings and payment of cash dividends allowed it to realize $1.3 million on its investment by 1996. The secondary offerings also trimmed $600 million from the acquisition debt by the end of 1991.

In September 1996, KKR sold Duracell to Gillette. Gillette had been looking for a new venture for five years, requiring, among other things, a strong consumer brand and a commitment to research and development.

Each Duracell shareholder would receive 1.8 shares of Gillette for each share of Duracell, for an initial value of $7.2 billion. (All stock figures account for a 2-for-1 stock split declared by Gillette in 1998.) By the time of this transaction, KKR still owned 34 percent of Duracell. The deal closed at the end of December 1996.

Just before the deal closed, Kravis (who would be joining the Gillette board of directors) got into a fight with Warren Buffett, who was on the board. KKR wanted Gillette to pay it a $20 million fee for negotiating the sale. Buffett thought the fee should be $8 million because that was the fee sale. Buffett though the fee should be $8 million because that was the fee Gillette paid each of its two investments banks. Kravis threatened to pull the deal unless he got the $20 million, and he got it.

Some of the limited partners wanted to see KKR immediately turn the Gillette stock into cash, but the strategy of patience paid off. The stock was trading at $39 at the time of the merger, and was trading at $48 six months later.

In February 1998, KKR sold 20 million shares for $1 billion. A weakness in Gillette stock in 1999 interfered with KKR's plan to sell at least half of its remaining stake. As of September 200, it still owned 51 million Gillette shares, worth $1.5 billion.

KKR and its investors have received $2.3 billion in cash and still hold stock (which is arguable undervalued) worth $1.5 billion. The total profit to date has been $3.8 billion, and KKR's cut (comprised of fees collected on the purchase and sale, management fees, and 20 percent of profits) has been about $800 million.

Michael Craig

4/4/07

NO COMMENTS YET

ADD YOUR COMMENT

Name	Email
Subject
Comment